Europe’s biggest fund managers are heeding policy makers’ warnings that an “excessive” search for yield is making bonds from companies in the region’s most indebted countries vulnerable to a selloff.

Pioneer Global Investments Ltd., which oversees $246 billion, said it cut holdings of corporate notes from most peripheral nations, while SEB AB in Stockholm, the manager of $191 billion of assets, lowered its recommendation to neutral from overweight. BlackRock Inc., the world’s biggest money manager, is underweight, while Amundi, the region’s largest asset manager, says it’s being more selective.

European Central Bank policy makers issued the bond-market alarm in their May financial stability review, as the recovery in the 18-nation euro region struggles to gather pace amid subdued pricing power and weak credit. Speculation the bank will ease policy further at its Governing Council meeting on June 5 helped push down yields on peripheral company debt to a record 1.58 percent last week, according to Bank of America Merrill Lynch data.

“It feels like walking into a trap,” said Juan Esteban Valencia, a credit strategist at Societe Generale SA in Paris. “Any little scare could make investors sell and if everyone wants to exit, there’ll be no liquidity.”

Crowded Trade

Buying bonds from Europe’s most indebted countries is the most crowded trade, according to 35 percent of fund managers surveyed last month by Bank of America Merrill Lynch. That’s up from 19 percent in April. Investors have been content to buy the notes since the easing in the sovereign debt crisis in mid-2012, the ECB said in its review.

“An excessive search for yield, which from a financial stability perspective, could make bond markets highly vulnerable to a repricing of risk stemming from the still fragile economic recovery and a normalization of U.S. monetary policy,” the ECB said.

Yields on Italian and Spanish bonds had their biggest one- day jump in almost a year on May 15, with the selloff showing the market isn’t immune to the volatility that characterized the four-year debt crisis. Investors were spooked by data revealing Italy’s economy unexpectedly shrank in the first quarter as well as political uncertainty in Greece.

The shock triggered the biggest rise since July in the extra yield investors demand to hold peripheral corporate bonds rather than benchmark government debt. As investors pared their holdings, the premium jumped to 115 basis points from 100 basis points, which was the least in more than six years, Bank of America Merrill Lynch index data show. The spread was 111 basis points May 29.

Illiquid Markets

“The weakness served as a lesson to people about what happens when you have crowded positioning in what are illiquid markets,” said Owen Murfin, a London-based manager in the global bond team at BlackRock, which oversees $4.32 trillion.

For the first time since 2009, yields on bonds sold by French and German companies were higher last month than for Spanish and Italian borrowers, Bank of America Merrill Lynch data show. Peripheral firms were even able to borrow cheaper than U.S. companies.

Telefonica SA sold eight-year notes yielding 2.242 percent in May compared with a yield of 2.445 percent on similarly-rated debt of the same maturity issued by U.S. phone carrier Verizon Communications Inc. and 2.465 percent from cable television channel operator Discovery Communications Inc. in February.

“Peripheral companies shouldn’t be trading below their core peers,” said Thomas Kristiansson, head of credit fixed- income at SEB. They “are still vulnerable,” he said.

Record Sales

Borrowers are making the most of the low rates, selling a record 27 billion euros ($37 billion) of securities this year, up 9 percent from the same period in 2013, data compiled by Bloomberg show. Greek issuers such as Public Power Corp SA, the nation’s largest electricity company, are on pace to raise the most since 2008 with 1.5 billion euros of bond sales.

The notes handed investors 3 percent in the first three months, the biggest quarterly returns since the start of 2012, according to Bank of America Merrill Lynch data. That compares with 2.4 percent on notes from companies in Europe’s core nations and 2.6 percent from high-yield borrowers across the region.

“We’ve been more cautious in recent months as much of the spread compression between the periphery and core has played out,” said Garrett Walsh at Pioneer in Dublin, which has reduced its holdings to about 5 percent overweight in the periphery from 15 percent in January. “The scope for further tightening is very limited.”